Victoria Nuland, US assistant secretary of state, commenting on Ukrainian policy on her mobile phone, as recorded and publicly distributed by the Russian special services in February 2014.
“Treason is a matter of dates.” Attributed to Prince Charles Maurice de Talleyrand-Perigord, drawing up European borders at the Congress of Vienna, 1815
The quality of US representation in eastern Europe seems to have declined, sadly, since the days of George Kennan and George Marshall in the 1940s and 1950s. European diplomacy, though, appears to have maintained the tradition of ethical flexibility that Prince Talleyrand embodied.
Whatever your opinion of the morality of Russia’s intervention in Ukraine, or whether the Putin government’s larger strategy will have more gains than losses for the Russian state, there is no doubt the Russians have tactically outmanoeuvred the US and Europe in the financial markets. I am told the Pentagon is already studying Russia’s financial market moves in Ukraine to see how similar tactics might be used in future military crises.
This is all pretty visible. Yet interestingly, the prices in an actively traded market in Ukraine’s internationally held foreign currency bonds do not reflect these realities. An issue due in September 2015 was priced at around 85 cents last week, for a yield of 28 per cent; another bond due in July 2017 could be bought for 80 cents, for a yield to maturity of 19 per cent.
Russian institutions have been quick learners in understanding the uses of international law bonds. The terms under which it sold gas to previous Ukrainian governments reek of corruption, but also good technical lawyering, the effectiveness of which was only slowly understood by people who should have known better, such as the US administration.
Take, for example, what the Americans now call “the booby-trap bond”, a $3bn bond issued by Ukraine to Russian holders a year ago, which is due in December 2015. It is not only enforceable under English law, but was registered on an Irish exchange. It has cross default clauses that are triggered if Ukraine misses a payment to any other entity controlled or majority owned by Russia. That includes a $1.6bn payment to Gazprom due at the end of this month. Oh, and Russia can call a default (which triggers a further default on the rest of Ukraine’s roughly $16bn bonded foreign debt) if the country’s debt to GDP ratio rises above 60 per cent – due, perhaps, to extortive Russian gas prices and a Russian-backed invasion and insurgency.
Thanks to a deep devaluation of the Ukrainian hryvnia, as well as the greater impoverishment of the population, Ukraine’s current goods and services account is probably close to balancing. However, its debt service burden is beyond the capacity of its foreign exchange reserves and forex earning capacity over the visible future.
For the next year, official western and multilateral agency funds will support payments on Ukrainian obligations such as that $500m, 6.875 per cent bond. At 85 it is arguably underpriced, since it comes due before the maturity of the Russian “booby trap bond” in December. However, by the time we get to 2017 or 2019, there could be a crushing burden of official and multilateral debt outstanding, which will claim seniority over privately held foreign bonds. At that point, a drastic outright “haircut” or “reprofiling” of maturities into eternity looks a good bet.
The only way for Ukraine to rebuild enough economic strength and earned foreign exchange to avoid the consequent legal and economic mess is to voluntarily impose effective anti-corruption measures and market-based pricing for energy and other goods that end the oligarch model of development. In turn, these reforms would need to evoke not just reductions in wasteful and corrupt use on the demand side, but new production on the supply side.
To anyone who has past experience with Ukrainian officials, this would appear to require intervention from, say, an archangel with a flaming sword. In this miserable winter, though, there may be enough popular sentiment against past practices to get the job started.
From the bondholders’ point of view, that is probably the only path to their being paid on schedule after the end of next year.